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A profit-boosting consolidation wave could be headed for China

2017/9/30 16:05:03

Policy makers are trimming capacity from bloated state enterprises, which helps sustain the rebound in factory inflation and boost corporate profit margins. Premier Li Keqiang has said reductions, which include aims to curb steel capacity by 150 million tons by 2020, are exceeding expectations and that new growth drivers are replacing old ones.

That means that while the survivor firms have better profit margins now, the world’s second-largest economy is also laying the groundwork for better returns in the long term. History in the U.S. shows consolidation delivered shareholder value in most cases, along with higher productivity and profitability in subsequent years, said Cui Li, head of macro research at CCB International Holdings Ltd. in Hong Kong.

Weaker construction-related demand and stricter environmental protection rules are driving consolidation, along with the government’s drive to rein in the risk from rising debt, Cui said. The materials sectors, including iron and steel, have been hardest hit, she said.

Consolidation will weigh on growth in the near term but remain manageable, Cui said, adding that there’s no sign softening in old-economy industries is stifling the rest of the economy.

Merging bigger state-owned enterprises and closing smaller, less-efficient companies may ease the rising debt burden on many factories and mines. Fewer players and less production aid pricing power of the remaining ones, which tend to be bigger, cleaner and more efficient.

The wave of consolidation is also washing into consumer and services industries, Cui said, citing car dealers, paper producers, brewers, budget hotels and air conditioner makers. The trend has longer to run, and sector-wide winners will be good investment opportunities.

Examples include Shanghai-based China Lodging Group Ltd. buying Beijing-based boutique operator Crystal Orange Hotel Holdings Ltd. this year, and acquisitions by Shanghai Jinjiang International Hotels Development Co. in both 2015 and 2016.